But stock investors should pay no heed to the "experts" who compete to manage their investments. They charge too much for adding no real value. Besides, their interests are opposed to the best interests of individuals saving and investing for the long term.
And the evidence for DIY passive index fund investing for the long haul is clear and unmistakable.
Consider this from The inspiration for John Bogle's great invention:
"This is the first installment of a series called "Things Written Long Ago That I Wish I Had Read Long Ago."
Let's look at the article "Challenge to Judgment" by Paul A. Samuelson which appeared in The Journal of Portfolio Management in 1974. "Challenge to Judgment" was cited by Vanguard founder John Bogle as the inspiration behind his decision to create the first index fund in 1976.
Paul A. Samuelson was professor of economics at the Massachusetts Institute of Technology and in 1970 he became the first American to win the Nobel Prize in Economic Sciences. He was the author of the best-selling economics textbook of all time — Economics: An Introductory Analysis . He served as an adviser to Presidents Kennedy and Johnson and was a consultant to the U.S. Treasury and the President's Council of Economic Advisers.
The point Samuelson wished to make in the article was written as a debate challenge:
"Resolved, that the best money managers cannot be demonstrated to be able to deliver the goods of superior portfolio selection performance. Any jury that reviews the evidence, and there is a great deal of relevant evidence, must at least come out with the Scottish verdict: superior investment performance is unproved."
Under Scottish law, a criminal trial can end with one of three verdicts — conviction, acquittal or not proven. The not proven verdict isn't an acquittal; it is a statement that insufficient evidence has been presented to the court to gain conviction. Hence, the phrase "Scottish verdict" means "unproved.”
Samuelson claimed that insufficient evidence exists to support the assertion that skilled managers can beat the market over the long term. He acknowledged that there may be a small subset of managers possessing what he called "flair" — the ability to repeatedly outperform market averages. But he insisted that if such managers exist, they are remarkably well hidden.
One reason for the relatively poor performance of active managers is that their buying and selling activity produces “deadweight transaction costs” that “suck economic resources out of useful GNP activities.” He maintained that most pension and trust fund managers could better serve their clients by trading less and holding more broadly diversified portfolios.
”But I suppose the fees to be earned by such sensible and prosaic behavior are less than from essaying to give it that old post-college try. What logic can demonstrate is that not everybody, nor even the average person, can do better than the comprehensive market averages. That would contradict the tautology that the whole is the sum of its parts. I would like to believe otherwise. But a respect for evidence compels me to incline toward the hypothesis that most portfolio decision makers should go out of business.”
“At the least, some large foundation should set up an in-house portfolio that tracks the S&P 500 Index — if only for the purpose of setting up a naive model against which their in-house gunslingers can measure their prowess.”He longed for a no-load, no management fee, low transaction, low turnover fund: “ At the least, some large foundation should set up an in-house portfolio that tracks the S&P 500 Index — if only for the purpose of setting up a naive model against which their in-house gunslingers can measure their prowess.”
Paul A. Samuelson
It seems only logical that hardworking, intelligent money managers should be able to find stocks that will outperform the market? After all, there is always someone who has outperformed the market in the recent past. But he insists that this proves nothing because, “Alas, anecdotes are not science.
In summary he states: “What is interesting is the empirical fact that it is virtually impossible for academic researchers with access to the published records to identify any member of the subset with “flair”. This fact, though not an inevitable law, is a brute fact. The ball, as I have already noted, is in the court of those who doubt the random walk hypothesis. (That stock prices change in a random, unpredictable manner in response to new information.) They can dispose of the uncomfortable brute fact in the only way that any fact is disposed of — by producing brute evidence to the contrary.”
Forty years later, we're still waiting for some brute evidence to the contrary. The evidence continues to validate Samuelson's position in "Challenge to Judgment.” Passive, index investors are grateful that John Bogle accepted Samuelson's challenge. Bogle started an investing revolution which today offers individual investors the opportunity to own low-cost, tax efficient, diversified index funds for almost every imaginable asset class.
After reading the prospectus of the Vanguard 500 Index Fund, Samuelson wrote, " sooner than I dared expect, my explicit prayer has been answered ." Speaking before an audience of investment professionals in Boston in 2005, Samuelson declared, “I rank this Bogle invention along with the invention of the wheel ...."
Summing Up
That's the history and rationale underlying index investing, and it's absolutely the proper thing to do for most individuals.
And it has been true for a very long time.
When investing, the 'deadweight transaction costs' charged by the "experts" and brokers are avoidable and should be avoided by individual investors.
These non-value added deadweight transaction costs over time merely serve to enrich the 'expert' while dramatically reducing, if not eliminating, the real inflation adjusted investment returns which would otherwise accrue to the benefit of the 'amateur' individual saver and investor.
Admittedly, I'm an amateur and a happy one at that.
Thanks. Bob.
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